UBS / Credit Suisse merger

Views from Invesco’s Fixed Interest teams on the current situation with regard Credit Suisse and AT1’s within the market. This is a rapidly changing situation and views are subject to change.

What happened over the weekend?

UBS has announced a takeover of Credit Suisse (CS) in an all-share deal that values CS at approximately CHF3bn. The deal was engineered by a combination of the Swiss regulator (FINMA), the Swiss government and the Swiss National Bank (SNB) and is not subject to a shareholder vote.

The SNB announced that it is providing substantial liquidity assistance to support the takeover. In addition, the Swiss government are providing a federal guarantee of CHF9bn to shield UBS against losses associated with the takeover. Further liquidity measures have been announced by other central banks, including the Federal Reserve, the European Central Bank and the Bank of England.

A crucial factor in the deal targeted bondholders as FINMA announced that “the extraordinary government support will trigger a complete write-down of the nominal value of all Additional Tier 1 (AT1) instruments of Credit Suisse”. This means that approximately CHF16bn in AT1 instruments is being fully written down to zero.

Initial impact on AT1s

The CS AT1s were already trading at distressed levels before the weekend. However, the full write-down of the AT1s is a significant surprise and these instruments are now trading at near-zero prices. The wider AT1 market is weak on Monday with heavy selling observed at market opening. As the day progressed, we saw buying of high quality AT1s.

Background information on AT1s

AT1 instruments form part of the capital that banks issue to meet their regulatory requirements. They are designed to have loss absorbing features to provide a buffer against bank failure. These features include trigger mechanisms which allow for the suspension of coupon payment, principal write-down or conversion into equity.

AT1 instruments are the most junior line of debt in the bank capital structure. As re-iterated by the European Banking Authority (EBA) today, AT1s sit above equity in terms of loss absorption, but below other debt, such as senior bonds and other Tier 2 instruments. Because of this relatively subordinate position in bank’s capital structure, they are typically the highest yielding form of bank capital and offer the opportunity to gain attractive levels of income and total return, on a risk-adjusted basis. Since the emergence of AT1 instruments in response to the new regulations put in place after the Great Financial Crisis, the asset class has grown to a full market value of approximately USD230bn (source: ICE BofA Contingent Capital Index, 28 February 2023).

Wider questions for AT1s

As discussed above, all AT1 instruments are designed to absorb losses. The most common mechanism for loss absorption in European bank AT1s is through equity conversion. The AT1s of Swiss banks are different to other jurisdictions in that they use only full write-down language. 

The full write-down on CS AT1s without any conversion to equity is likely to have a negative impact on the AT1 market as a whole beyond this particular episode. The subordination of AT1 to equity in this case (the AT1 is fully written down while equity holders get some recovery and potential upside once converted to UBS equity) will lead investors to reconsider the risks of AT1s compared to other parts of banks capital structures.

On Monday morning the EBA reiterated that Core Equity Tier 1 capital takes losses before AT1 debt. This should help to limit the negative fallout for the bulk of European banks. It is worth stating that the circumstances affecting CS are unique to them.